The controversy over a paid-for stock endorsement by Tobin Smith, a money manager who has been a fixture on television news shows for 15 years and until this week a regular on Fox News, calls attention to the difference between “sponsored investment research” and independent analysis. Whether real, independent ...

Most investors can’t tell the difference between “sponsored investment research” and independent analysis, and that’s exactly what the “sponsors” – typically small companies paying for a marketing campaign that will inflate their stock activity and value – are counting on.

The difference gets even tougher to figure out when the sponsor hires someone who is known for giving independent commentary colored only by his own feelings and research.

Think of it as a big, honking commercial, with a celebrity endorser.

Last week, that bought-and-paid-for stock endorsement was a 20-page mailer about Petrosonic Energy, supported by an email campaign, featuring Tobin Smith, a money manager who has been a fixture on television news shows for 15 years and who has been a regular on the Fox networks until this week – when Fox terminated him after it learned about his outside ventures in stock promotion from me – describing himself on Twitter as a “guest anchor.” According to Fox, he was a “contributing market analyst for Fox News Channel and a regular panelist on ‘Bulls & Bears.’” (Fox, like my employer MarketWatch, is owned by News Corp.)

While investors might have ordinarily treated the “special edition” of the new Next Big Thing Investor newsletter – Smith’s latest, just-started investment newsletter – like junk mail or spam, Smith’s name and his smiling, personable countenance had some investors doing a double-take, at least judging from the emails I received on the subject

The people who contacted me considered buying the stock entirely based on Smith’s say-so, and the credibility he exudes in his Fox appearances. They didn’t appear to read the disclaimers of the campaign; had they bothered, they would have quickly found it was paid advertising for which Smith’s company pocketed $50,000.

This is a unique case because of how recognizable Smith is, and it brings into focus credibility questions that I’ve found most investors fail to answer even as they are deciding who they can trust. While Smith never mentioned Petrosonic while appearing on Fox, the network’s official policy is that “no Contributor to FBN, nor his/her firm, and/or family members are allowed to accept financial consideration of any kind whatsoever to issue research, advertisements, or to otherwise promote individual stocks or securities.” On Tuesday afternoon, Fox terminated Smith’s contract; asked earlier whether he had violated Fox’s rules, Smith said, via text message, “that policy was added late last year ... my contract was not subject to that clause ...”

Petrosonic could not be reached for comment.

The campaign started with Petrosonic – there’s a disclosure in the company’s annual report noting that it hired a firm “that provides strategic investor relations services” – but the issue here is not so much about what is being touted as by who is doing the touting, why they are doing it, and whether the audience can tell the difference between independent analysis and advertising cloaked in the guise of analysis.

Page 2 of 4 - Smith told me it’s actually better to have the company – rather than a third party with a big wad of shares – backing these campaigns because it’s more “like public venture capital” than a play to pump the stock. Either way, the Petrosonic blitz last week helped the stock gain roughly 20 percent.

And with Petrosonic up over 40 percent on a year-to-date basis and more than 135 percent in the last year – prior to my writing about Smith’s involvement which resulted in a huge decline over the ensuing days – anyone who couldn’t see past the smiling face of the popular, charismatic Smith might have thought the stock really was “the investment opportunity of your lifetime,” as it’s described in the flyer.

It’s hard to see that status if you barely scratch beneath the veneer of the promotion. For one, there’s the company’s lack of revenues, as in zero, according to filings, though Petrosonic did issue a press release late last week about how the company – which says it has a unique process for upgrading heavy oil – is now generating revenue from its plant in Albania.

Also overlooked in the hype are Petrosonic’s rising losses, negative cash flow and the “going-concern letter” from auditors who think there is “substantial doubt” in Petrosonic’s ability to survive. In its regulatory filings – where all of those conditions are readily evident – Petrosonic notes that the business will fail if it can’t generate adequate cash/financing; those concerns aren’t mentioned in Smith?s “special report.”

Small-potatoes newsletter editors sell off their credibility all the time. There’s nothing new there; what’s different is Smith’s high profile.

Smith built his reputation around some timely investment picks, a best-selling book – “ChangeWave Investing” – and his personality and media presence. He was perhaps best known for being an early entrant into Canadian royalty trusts at a time when the U.S. market was in the tank; his stature grew as a result, as did his reputation.

How much that reputation was deserved on the basis of investment selections and analysis is an open question; Hulbert Financial Digest – which tracks newsletter performance and is a MarketWatch property – shows that from August 2002 through June of 2010, the ChangeWave Investing newsletter had an annualized total return of 0.6 percent, compared with a 4.6 percent return on the Wilshire 5000.

Smith sold ChangeWave Research in 2010 and agreed with the buyers to stay out of the newsletter game for at least two years, but that time has passed and he is launching his “Next Big Thing.” Meanwhile, his new NBT Group added “investor relations” to his resume. A positive spin – Smith’s, in fact – suggests that this kind of sponsored research makes the pitch to the public, so that they can provide venture capital for a business that can’t get that funding through traditional Wall Street channels; a less charitable take (mine) is that he’s taking money to help small stocks find a market using fluff-and-shine hyperbolic chatter, with streams of press releases aimed at novice investors who fail to do due diligence.

Page 3 of 4 - “The problem with sponsored research is that no one reads it because no one knows who it is,” said Smith, who noted that entrepreneurs pursue direct-marketing campaigns hoping to keep more of their personal stake in the fledgling business while generating the capital needed to push it to success. “I am certainly the only 15-year cable news guy who is willing to sully himself talking about stocks in the under $500 million marketplace. ... If I am guilty of being someone people know who goes into the sponsored-research business, I’m willing to take that shot, because I do believe there are very good companies and good management teams that are basically orphans in the investment community, and interest in those good companies is not going to happen out of the blue. Someone has to sell the message to get the stock trading, because without that trading the public capital markets are closed to a company.”

The problem is that Smith’s message doesn’t read like that of the Fox commentator or investment expert, but feels like a sales pitch.

He is aware of the Petrosonic’s negatives, but did not mention them in his newsletter. Smith – who said he does not hold any shares of PSON – told me that going-concern letters are a staple of small, negative-cash-flow microcap penny stocks and start-ups, and he noted that some big brand-name companies overcame similar concerns in their early days. He noted that the revenue issues were addressed, as noted by the new press release.

But he also noted that the investor-relations job is to create some buzz over a stock, which isn’t going to happen with “too much focus on the risks.”

Alas, there was not even a momentary focus on the risks in the report. Moreover, according to the fine print, the report “does not purport to provide an analysis of any company’s financial position.”

That disclaimer notes that outside research and writers were used to put together the advertisement but lays the responsibility for the content in one place, noting that “the opinions expressed ... are solely those of Tobin Smith.”

The average investor won’t find those conflicts without looking for them. In fact, I have known Smith for years (and have appeared on several programs with him), and it’s mostly the missing negatives – hard to spot if you’re not looking for them – that I see as the difference between this sponsored pitch and something he might say that is completely independent.

That distinction – walking the fine line between what an analyst believes and what they are somehow compensated or incentivized to believe – is what this situation should showcase to investors.

Whether real, independent journalism and analysis is dying or simply being overrun in the everyone-can-be-in-the-media age we live in, investors must look for conflicts of interest, even from the names they trust. Plenty of news sites – MarketWatch included – run pieces from experts with skin in the game, and even though most sites are clear about when writers have a personal stake in the subject, such disclosures might be inadequate for the average reader.

That’s the moral of the story: Before taking a published tout from anyone, see if you can find any conflicts of interest or other problems. Only when you are satisfied that the tip is legitimate and honest should you even consider proceeding with it.

Dan Wiener of the Independent Adviser for Vanguard Investors, speaking generally about sponsored research, noted: “Faking independence and acting as a paid shill for a penny stock is the lowest form of deceit.”

Brent Wilsey of Wilsey Asset Management in San Diego – who once appeared on-air with Smith years ago – said that money managers and media commentators “get paid many times over by having viewers/readers know [they] have no bias at all on what [they] are writing or speaking about. “I think an editor has no credibility at all when they are paid by the company.”

For his part, Smith says this move will not damage his credibility ? especially because he believes the stock really will pay off.

In the end, if the first instinct is to ignore a tip or throw it out, trust that gut feeling; if there’s any inclination to pursue a recommendation, make sure you know where it is really coming from and the motivations for it before committing any money to it.